ChapterChapter 12 12 International Equity Financing hen a company lists its shares on a stock market, it seeks to access capital from a wide W pool of investors. Apart from this primary market at the time of an initial public of- fering, the daily trading of a corporation’s shares among investors (the secondary market ) provides an objective, forward-looking valuation of the company’s activities. This activity determines the cost of additional equity capital: The more investors are willing to pay for a company’s shares, the cheaper will be additional capital when the company issues addi- tional shares. Consequently, everything that affects stock market prices is important for a capital-hungry multinational corporation (MNC). (However, we leave a formal discussion of the international cost of capital to Chapter 13 .) Another benefit of listing on a public stock exchange is that the presence of a stock market price can be used to align the interests of managers with the interests of shareholders in management compensation schemes. This chapter examines how and why MNCs list their shares on international equity markets. Most MNCs list their shares on the stock exchanges of the countries in which they are headquartered. However, many MNCs also list their shares on stock exchanges located in other countries. For example, in 2010, the total value of shares traded in the stock of Nokia on the New York Stock Exchange (NYSE) exceeded $70 billion. Such a large volume for a single company is not unusual for the NYSE. For instance, IBM’s total NYSE trading volume dur- ing 2010 was well over $150 billion. Nevertheless, Nokia, which is one of the world’s premier mobile phone companies, is headquartered in Finland, in contrast to IBM, which is a U.S. com- pany. Even though U.S. investors can directly buy Nokia stock on the Finnish stock exchange in what is called cross-border trading, Nokia must find this international (“cross-exchange”) stock listing valuable. Why? After first giving you a tour of the world’s stock exchanges and how they work, we explore the advantages and disadvantages of cross-listing. 12.1 A TOUR OF INTERNATIONAL STOCK MARKETS The Size of Stock Markets Exhibit 12.1 indicates that the U.S. stock market capitalization was about 31% of the world’s stock market capitalization at the end of 2010. The second-largest market is that of Japan, which is followed by China, the London Stock Exchange (which combines the exchanges of the United Kingdom and Italy), and India. 1 1 Because not all exchanges in the world are part of the World Federation of Exchanges, from which we pull the data, we miss some reasonably sizable markets, such as New Zealand and the Czech Republic. 398 Exhibit 12.1 Market Capitalizations of Stock Exchanges Market Capitalization (in millions of U.S. dollars) 1991 (% of world total) 2000 (% of world total) 2010 (% of world total) Market Type United States 4,087,660 36.03% 15,104,037 46.82% 17,283,452 31.41% Developed Japan 3,130,863 27.60% 3,157,222 9.79% 4,099,606 7.50% Developed China 2,028 0.02% 580,991 1.80% 4,027,840 7.34% Emerging London Stock NA NA NA NA 3,613,064 6.58% Exchange United Kingdom 987,952 8.71% 2,567,992 7.99% Developed Italy 158,865 1.40% 768,364 2.38% Developed India 47,730 0.42% 148,064 0.46% 3,228,455 5.88% Emerging Euronext NA NA NA NA 2,930,072 5.34% Developed Belgium 71,319 0.63% 182,481 0.57% Developed France 348,083 3.07% 1,446,634 4.48% Developed Netherlands 136,158 1.20% 640,456 1.99% Developed Portugal 9,613 0.08% 60,681 0.19% Hong Kong 121,986 1.08% 623,398 1.93% 2,711,316 4.94% Developed Canada 266,874 2.35% 841,385 2.61% 2,170,433 3.95% Developed Brazil 42,759 0.38% 226,152 0.70% 1,545,566 2.82% Emerging Australia 145,511 1.31% 372,794 1.16% 1,454,491 2.65% Developed Germany 393,454 3.47% 1,270,243 3.94% 1,429,719 2.60% Developed Switzerland 173,881 1.53% 792,316 2.46% 1,229,357 2.24% Developed Spain 147,928 1.30% 504,219 1.56% 1,171,625 2.13% Developed Korea 96,373 0.85% 171,587 0.53% 1,091,912 1.99% Emerging OMX Nordic NA NA NA NA 1,042,154 1.90% Developed Denmark 44,841 0.40% 107,666 0.33% Developed Estonia NA NA 1,846 0.01% Finland 14,271 0.13% 293,635 0.91% Developed Iceland NA NA 4,439 0.01% Developed Latvia NA NA 563 0.00% Lithuania NA NA 1,588 0.00% Sweden 100,913 0.89% 328,339 1.02% Developed Russia 244 0.00% 38,922 0.12% 949,149 1.73% Emerging South Africa 168,497 1.49% 204,952 0.64% 925,007 1.69% Emerging Taiwan 124,864 1.10% 247,602 0.77% 838,401 1.53% Emerging Singapore 47,367 0.42% 152,827 0.47% 647,226 1.18% Developed Mexico 98,178 0.87% 125,204 0.39% 454,345 0.83% Emerging Malaysia 58,627 0.52% 116,935 0.36% 408,689 0.74% Emerging Indonesia 6,823 0.05% 28,834 0.08% 360,388 0.66% Emerging Saudi Arabia 48,213 0.42% 67,171 0.21% 353,410 0.64% Not specified Chile 27,984 0.25% 60,401 0.19% 341,799 0.62% Emerging Turkey 15,703 0.14% 69,659 0.22% 307,052 0.56% Emerging Norway 22,043 0.19% 65,034 0.20% 295,288 0.54% Developed Thailand 35,815 0.32% 29,489 0.09% 277,732 0.51% Emerging Israel 6,176 0.05% 64,081 0.20% 227,614 0.41% Developed Colombia 4,036 0.04% 9,560 0.03% 208,502 0.38% Emerging Poland 144 0.00% 31,279 0.10% 190,232 0.35% Emerging Philippines 11,386 0.10% 51,554 0.16% 157,321 0.29% Emerging Austria 7,689 0.07% 29,935 0.09% 126,032 0.23% Developed Peru 1,118 0.01% 10,562 0.03% 103,348 0.19% Emerging Luxembourg 11,308 0.10% 34,016 0.11% 101,129 0.18% Developed Iran 34,282 0.30% 34,041 0.11% 86,642 0.16% Not specified Egypt 2,651 0.02% 28,741 0.09% 84,277 0.15% Emerging Greece 13,118 0.10% 110,839 0.34% 67,586 0.12% Developed Argentina 18,509 0.16% 166,068 0.51% 63,910 0.12% Frontier Ireland NA NA 81,882 0.25% 60,368 0.11% Developed Jordan 2,512 0.02% 4,943 0.02% 30,864 0.06% Frontier Hungary 505 0.00% 12,204 0.04% 27,708 0.05% Emerging (continued) Chapter 12 International Equity Financing 399 Exhibit 12.1 Market Capitalizations of Stock Exchanges (Continued) Market Capitalization (in millions of U.S. dollars) 1991 (% of world total) 2000 (% of world total) 2010 (% of world total) Market Type Sri Lanka 1,936 0.02% 1,074 0.00% 19,924 0.04% Frontier Slovenia NA NA 2,547 0.01% 9,384 0.02% Frontier Mauritius 312 0.00% 1,331 0.00% 7,753 0.01% Frontier Cyprus 1,290 0.01% 11,516 0.04% 6,834 0.01% Not specified Malta NA NA 2,009 0.01% 4,194 0.01% Not specified Bermuda NA NA 2,146 0.01% 1,535 0.00% Frontier Total World Market 11,345,733 32,260,433 54,884,333 Notes : The data are taken from the World Federation of Exchanges, Datastream, and the S&P>IFC database. The indications “Developed,” “Emerging,” and “Frontier” are from Morgan Stanley Capital International. The relative market capitalizations of the different exchanges around the world are in constant flux, however. At one point in the 1980s, Japan’s stock market was the world’s largest. The dominance of Japan’s stock market was also somewhat artificial because cross- holding grossly inflated the numbers. Cross-holding refers to the practice of one firm owning shares in another firm. If both of these firms are listed on an exchange, and one calculates total market capitalization by merely multiplying the total number of shares outstanding by the market price per share, the market capitalization will be overstated because part of the value of the shares is essentially double-counted. Let’s illustrate this with a hypothetical example. Example 12.1 Cross-Holding of Shares Assume that Companies A and B are each worth $100. Hence, the total market capital- ization of the two companies is $200. Suppose both companies are fully equity financed, so we can represent their balance sheets as follows: Company A Company B Assets Liabilities Assets Liabilities $100 $100 $100 $100 Here, liabilities represent owner’s equity, and assets represent plant and equipment. If there is no intercorporate share ownership, $200 represents the true value of the assets of both companies and, consequently, the true value of their shares. Now, sup- pose Company A issues $50 in new shares and buys $50 of the outstanding shares of Company B in the secondary stock market. Whereas the balance sheet of Company B remains unchanged, the balance sheet of Company A becomes Company A Assets Liabilities Physical Assets $100 $150 Investment in Co.